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As I mentioned yesterday, my father-in-law came to visit over the weekend, and we started talking about my brother-in-law, who is in the Coast Guard. Let me back up. Remember I went to the Coast Guard Academy. My brother-in-law, then twelve years old, came to my graduation. He was so inspired that he decided to become a Coast Guard officer, too. Well, the funny thing about joining the ranks of government employees is that the government has a fair understanding of economics, too. They know that you have to make economic choices. For me, going to the Academy was an easy choice because there was little money available for a private institution. Similar circumstances for most of the kids I went to school with. Mostly poor kids. [Sidebar: even though Navy, Army etc. are also free, their students tend to be significantly more well-off, because you need a political appointment to be considered for admission. No such requirement exists for the Coast Guard.] Now, its not exactly free, because you have to serve five years afterwards. That is clearly not free. Towards the end, I was getting paid about $45,000 a year, when you take into account all my allowances. So the economics of getting out and going to work at LEH were pretty easy. Even a chimpanzee can NPV that one. But my brother-in-law graduated from CGA in 2008. So his five years were up in 2013. What was his calculus for whether to stay in or not?

He was getting paid about $75,000 a year. And there were no LEH-like jobs out there that he could move to. So he stayed in. Then, he was faced with another economic choice. He wanted to go to graduate school to get a Masters in mechanical engineering. The Coast Guard will pay for it, but you have to pay them back double in service. For a 2-year program, you will owe 4 years. So my brother-in-law did 5 years of service, is finishing up 2 years of grad school, and will owe four years of payback as a bureaucrat in D.C. That will take him to 11 years. Now, once youre at 11 years, you have a decision to make. You can get out then, with two (free) degrees, at age 33, or you can put in the extra nine years and retire at age 42, and get 50% pay for the rest of your life. If you live to 102, you can get paid for 60 years, with cost of living adjustments. Most people choose to stay in until 20 years. That seems to be my brother-in-laws plan. Of course, if you try to change careers at age 42, it is harder than at age 33 or 27, because you have 20 years of government bad habits, and your earning power is limited, but you have that annuity payment for the rest of your life. Thinking back to when I was in business school, I took a class on decision theory like most people did, and you learn about this concept known as the certainty equivalent. You have a risky choice and a riskless choice. You

BROTHER-IN-LAW

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can NPV both. What amount of risk-free money makes you forgo the risky choice? In my case I could choose between: 1) Making an average of $60,000 over my

career and retiring with $30,000 annually, or

2) Making something between multiple six figures, even seven figures, or zero, if I blew up.

My brother-in-laws choice is: 1) Making an average of $100,000 over

his career and retiring with $50,000 annually, or

2) Doing something similar in the private sector, but being on the hook for health insurance, housing, all that stuff.

Pretty easy choice. Sometimes when I am talking with my wife, I sort of harsh on my brother-in-law for being such a stooge. And in some ways, he is the ideal government worker. Puts in his eight hours, doesnt work too hard, certainly doesnt grow a brain and ask too many hard questions. But really, he is just being a rational economic actor. It would be irrational for him to get out of the Coast Guard, unless he could find a job making $200K-$300K a year, which he cant. So why get upset with someone who is behaving rationally? I am very happy I got out, but the economics made it a very easy decision. I would not want to be in the position where I wanted to get out, but found it financially difficult to do so. Some people do that. They get out, and make less money, just because they are sick of all the crap. That, too, is a rational decision. Just like when Wall

Street guys are sick of all the crap but get paid too much to leave. I try not to criticize other peoples economic decision making. It is actually more subjective than you think. I tend to place a higher value on freedom. There are trade-offs.

NOW Sorry to write about Canada for two days in a row, but its necessary. This trade is like the Kansas City Royals of macro trades. Everyone is jumping on the bandwagon. It is more than just bank earnings (which we will talk about tomorrow). There is a lot more to the story. Jumping on the bandwagon is good, though. It means that other people are starting to see the merits of this trade. I am no longer the lonely voice in the woods. In fact, some people are being smarter about it than I am. For instance, they are correctly saying that it is mostly the price of oil (and other commodities) that is going to bring Canada down. Not housing. Housing will turn a plain vanilla commodity bust into a massive kablooey, and heres the takeaway: a lot of these bandwagon folks are going to put the short Canada trade on and take it off after they make 20-30%. No. It is going to be much bigger than that. This is a multi-bagger. And it is just beginning. In the spirit of the trade finally beginning, I think it is time to increase my allocation to short Canadian banks. It is funny how you can go from being too big in a trade to too small in just a couple of days. So in 24 hours, I am going to short more CM and TD.

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Here are charts of CM and TD, if you havent seen them in a while.

Source: Bloomberg

Source: Bloomberg

For the time being, people are focusing on the loss of investment banking business, which will be substantial. But nobody is looking at the second and third derivatives. I have been yapping about the housing piece for about two years now, but were not even to that point yet. Not even close. Id say that things are going to get sloppy but they are already starting to get kind of sloppy. Mr. Market gets tougher and tougher to deal with. The meltdown in Canada has been so rapid, that you had virtually no chance to get in, unless you were like me, getting your teeth kicked in for the last year. So for the benefit of everyone who has been round-filing my Canada issues, with the banks down 15%, do you still short em here? I am going to be adding to the shorts, as I said, in 24 hours. I think there is plenty more downside to go. Something just popped into my head. Remember when Bill Miller beat the SPX for 15 years straight, then completely blew sky-high? I have this theory about how a particular strategy can work for years, even decades, but it will always fail you in the end. What if there is a Buffett unwind at some point in the future? Buffett pursues a particular strategy. Its not quite value investing, but he buys stuff that used to be value thats on all-time highs, then does some kind of asset swap for tax purposes. Or he gets bank preferreds. Either way, it wouldnt surprise me if the Buffett algorithm breaks down in 2015, starting with the rails. Being long the economy is one thing, but hes leveraged long.

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